5.1 Taxes, Net Income, and Budgeting

Worked Examples

Key Terms

• Annual Income Tax Return
• Budget
• Capital Gains Tax
• Deduction
• Dependent
• Discretionary Spending
• Emergency Fund
• Fixed Expense
• Gross Income
• Income Tax
• Mandatory Deductions
• Marginal Tax Rate
• Needs
• Net Income
• Pay Stub
• Payroll Taxes
• Pre-Tax Deductions
• Progressive Tax
• Property Tax
• Sales Tax
• Savings Rate
• Self-Employment Tax
• Tax Credit
• Tax Deduction
• Tax Refund
• Taxable Income
• Taxes
• Variable Expense
• Voluntary Deductions
• Wants
• Withholding

Practice Questions

4 questions. Nothing here is recorded or scored.

1. Question 15.1.A.2, 5.1.A.4

   Copperleaf Garden Center

   Odette Quillen works part time at Copperleaf Garden Center, where her hours swing with the season: about 14 hours a week for most of the year and 34 hours a week through the ten-week spring planting rush, at $15.00 an hour. Her pay for the full year adds up to $13,920, which lands below the income level at which federal income tax begins, so the federal income tax she owes for the year works out to zero. Federal income tax still came out of her spring checks, $270 across the rush, because the payroll table reads each check as though the whole year paid at that week's rate. Social Security and Medicare come out of her checks year round. The owner has now offered Odette the lead grower job for next season at $19.00 an hour, and she is hesitating, because a friend told her that earning more can push a person into a higher tax bracket and leave her worse off.

   Which of the following best describes what happens to the $270 of federal income tax withheld from Odette's spring checks?

   • A.Copperleaf returns it in her last spring check, once her weekly hours drop back down.
   • B.It stays with the government, because tax withheld from a paycheck settles the bill.
   • C.Filing an annual return brings it back, since the withholding prepaid a bill of zero.
   • D.It counts toward the Social Security and Medicare credits she is building, so it stays paid.
   Check answerHide answer

   Answer: C

   A.

   The employer is a collector, not a bank. Copperleaf sends what it withholds to the government on a set schedule, so by summer the $270 is already out of the garden center's hands, and the return Odette files is what brings it home.

   B.

   Treats a prepayment as a final bill. Withholding is an estimate paid in advance, and the actual bill is figured only once the year is finished and the return is filed. When the estimate runs above the bill, the difference comes back.

   C.

   Correct. Income taxes are a percentage of income paid to the government, and for an employee the employer withholds a portion of each paycheck and pays it in directly. The household then files an annual income tax return to pay whatever is still owed or to reclaim an overpayment. The payroll table read one $510 spring week as though the whole year ran at that pace, but Odette's real year came to $13,920, below where federal income tax begins, so the tax owed is zero and the $270 was an overpayment from the first dollar. Filing brings it back as a refund, which is money she loaned the government at no interest rather than a bonus for working the rush.

   D.

   Splits the difference between two lines on the stub. Social Security and Medicare are payroll taxes that fund those programs, and those dollars do stay paid and do build credits. The $270 line is federal income tax, a separate tax that gets settled on the return.

2. Question 25.1.B.2, 5.1.B.1

   Odette asks whether moving up to $19.00 an hour could leave her with less money after taxes than she keeps now. Which of the following is the best response?

   • A.Yes, because a higher hourly rate moves her whole year of pay up to the higher rate.
   • B.No, because the higher rate applies only to the income above the cutoff.
   • C.No, because her federal income tax rate stays the same at any income she is likely to earn.
   • D.Yes, because the payroll taxes withheld from her checks climb with her hourly rate.
   Check answerHide answer

   Answer: B

   A.

   This is the worry stated as a rule, and it is the part the friend got wrong. A progressive system does not go back and re-rate income that was already earned below the cutoff; the higher rate reaches forward to the dollars above it.

   B.

   Correct. The U.S. federal income tax is progressive, so higher incomes are charged higher rates, and the rate that climbs is the marginal rate, the rate on the last dollar earned. Raising Odette's pay from $15.00 to $19.00 an hour lifts her year above the level where the tax begins, and the new rate lands on the income above that line rather than on the income below it. She keeps less of each added dollar than she would have kept tax free, and she still ends up with more money than she has now. What the raise is worth turns on the job itself, not on a fear of the bracket.

   C.

   The right verdict for a reason the framework contradicts. Federal income tax rates do climb with income, and at $19.00 an hour Odette's year would rise past the point where the tax starts, so her rate is going to move. What holds steady is the rate charged on the income below the cutoff.

   D.

   The premise is accurate and the conclusion does not follow from it. Social Security and Medicare take a set percentage of pay, so a bigger check means a bigger payroll line and a bigger amount left after that line comes out.

3. Question 35.1.A.6

   A hardware store rings up a customer's purchase of $64.00 in goods, and the state charges a 6 percent sales tax on the sale. Which of the following conclusions is supported?

   • A.The customer pays $67.84, and the store submits the $3.84 to the government.
   • B.The customer pays $67.84, and the $3.84 is revenue the store earned on the sale.
   • C.The customer pays $64.00, since the store owes the tax out of its own sales price.
   • D.The customer pays $67.84, then reports the $3.84 later on a household tax return.
   Check answerHide answer

   Answer: A

   A.

   Correct. A sales tax is based on the sales price of an item, so 6 percent of $64.00 is $3.84 and the register total comes to $67.84. The business selling the item collects that tax and submits it to the government, which means the $3.84 passes through the store on its way somewhere else.

   B.

   Counts the tax as earnings. The store handles the $3.84 but owes it to the government, so it belongs in a tax payment rather than on the store's revenue line, and treating it as income leaves the store short when the payment comes due.

   C.

   Puts the tax on the wrong side of the counter. Sales tax is added to the sales price and paid by the buyer at checkout, and the seller's job is collecting that money and passing it along.

   D.

   Sends the payment to the wrong filer. An annual income tax return settles a household's income tax, while sales tax is submitted by the business that collected it, which is why the customer's part of this job ends at the register.

4. Question 45.1.A.3

   Two years ago a household bought shares in a fund for $3,000 and this year sold those shares for $4,200. The household also earned wages during the year. Which of the following best describes how the $1,200 gain is taxed?

   • A.The gain is withheld from the household's paychecks during the year of the sale.
   • B.The gain goes untaxed, since tax was already paid on the income used to buy the shares.
   • C.The gain is taxed at the same rate as the household's wages for that year.
   • D.The gain is reported with the annual return, usually at a lower rate than wages.
   Check answerHide answer

   Answer: D

   A.

   Withholding is an employer's job, and it covers pay. Nobody withholds tax from a sale of shares, so the gain reaches the government through the return the household files rather than through a paycheck.

   B.

   Taxes the wrong dollars. The $3,000 the household put in was taxed back when it was earned, and the tax here falls on the $1,200 the shares gained on top of that purchase price.

   C.

   Half of this holds up. The gain is reported on the same return as the wages, and that is where the similarity stops, because a capital gain is charged at its own rate rather than at the rate on ordinary income.

   D.

   Correct. A capital gain is what an asset earns above what was paid for it, here $4,200 minus $3,000, or $1,200. Capital gains taxes are submitted with the household's annual income tax return, and the rate charged on the gain is typically lower than the rate the same household pays on the income it works for.

CED Codes

5.1.A.1 · 5.1.A.2 · 5.1.A.3 · 5.1.A.4 · 5.1.A.5 · 5.1.A.6 · 5.1.B.1 · 5.1.B.2 · 5.1.B.3 · 5.1.B.4 · 5.1.C.1 · 5.1.C.2 · 5.1.C.3 · 5.1.C.4 · 5.1.C.5 · 5.1.C.6